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The Korean Economy Beyond the Crisis

Edited by Duck-Koo Chung and Barry Eichengreen

Providing an integrated analysis of the event and its consequences, the chapters in the book consider the causes of the crisis, the response of the US government and International Monetary Fund, adjustments in the Korean monetary and fiscal policies, and the success of financial and corporate restructuring. The concluding chapters bring the story up-to-date, describing the aftermath of the crisis and assessing whether there has been sufficient reform to facilitate the country’s recovery and growth.
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Chapter 5: The monetary policy response to the crisis

Dongchul Cho


1 Dongchul Cho INTRODUCTION Korean history will probably record the last three years of the twentieth century as a period of dramatic economic policy experiments. Reforms affected virtually the entire economy, from financial and labor markets to the corporate and government sectors. Macroeconomic policy was no exception. Immediately following the outbreak of the crisis, the fiscal authority decided to mobilize funds totaling more than 12 percent of GDP for purposes of financial sector restructuring. But this was nothing compared to the revolution in monetary policy. In November and December 1997, when the currency crisis was triggered, stabilization of the exchange rate had been the foremost policy objective. Before the crisis, the fluctuation of the currency was limited to a narrow range, and a variety of restrictions were maintained on capital inflows and outflows. The crisis led to a complete change: the exchange rate was allowed to float freely, and the capital account was liberalized. Inflation targeting was introduced as a legal mandate, and the intermediate target of monetary policy was shifted from the monetary aggregates such as M2 to short-term interest rates.2 Perhaps the most dramatic and controversial aspect was interest rate policy. Overnight interbank call rates were raised to more than 30 percent from the previous level of 12 to 13 percent in order to attract capital inflows and limit outflows. Partly in response, the GDP growth rate plunged to –8 percent (year-on-year) in the second quarter of 1998, and the unemployment rate skyrocketed...

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